IRREVOCABLE LIFE INSURANCE TRUST Q&A’s

  • What is an irrevocable life insurance trust (ILIT)?
  • An irrevocable life insurance trust or ILIT (pronounced "eyelet”) is a trust that is funded, at least in part, by life insurance policies or proceeds. It is an effective estate-planning tool that, if properly structured, may help avoid generation-skipping transfer, gift, and estate taxes. It can also be a great way to ensure that your heirs will be able to keep your business running after you die, and/or provide a source of liquid funds to your estate for the payment of taxes, debts, and expenses.

  • How does an ILIT work?
  • One of the most important strengths of an ILIT can be the avoidance of estate taxes. This is accomplished by keeping the life insurance policy proceeds out of your taxable estate. However, if you remember nothing else, remember that the IRS will successfully challenge an ILIT if all the rules are not followed. A successful challenge means that the IRS may take as much as 55% of your life insurance. In order to avoid a successful challenge by the IRS, it is imperative that you follow all these steps closely:

    1)   Do not retain any incidents of ownership

    Incidents of Ownership is a legal term which means you have a right to benefit economically from the policy. The IRS will look for some evidence that you had control over the trust or the policy contained in the trust. This evidence would include, changing the beneficiaries, changing the trustee, or borrowing against the policy. The term, Irrevocable, means just that. Once the trust is established and funded, you can’t touch it, change it or end it (except, perhaps, by letting the policy lapse). Essentially, you say goodbye to the right to control what you put in it. An attempt to reassert control over the trust means you risk destroying the intended tax benefits.

    2)  Never make contributions to your trust that are equal to the required premium

    When you receive a premium notice from M&A Counselors, you will notice that the requested amount always differs from the actual premium. This will avoid a potential claim by the IRS that the trust contributions were nothing more than a premium payment.

    3)  NEVER NEVER NEVER make a premium payment directly to the Insurance Company

    While this can technically be listed as an Incident of Ownership, it is important enough to be mentioned separately. Paying your insurance provider directly is a sure way defeat your trust’s tax benefits. If you have been paying on a policy yourself, please contact us before another payment goes out.

  • Can I add a policy to my trust?

  • Yes, but there are certain rules (of course) that must be followed for you to enjoy an immediate tax benefit on a newly transferred policy. If you purchase a life insurance policy with the intent of moving it into your trust, it must be held by the trust for three years before the proceeds will pass outside your taxable estate. In other words, if you die within three years following the transfer, all the proceeds from the new policy will be brought back into your taxable estate. This is creatively called the three-year rule. To avoid this waiting period, make a contribution to the trust large enough for it to purchase the new policy with itself as owner and beneficiary.

  • What is a Crummey Notice?

  • The issuing of Crummey Notices is another rule that must be followed in order to stand up against an IRS challenge. However, it is the Trustee’s responsibility, not yours, to send these out. The Crummey Notice gives the beneficiaries the right to demand, for a limited period of time, any amount you contributed to the trust. These notices must be issued to appease the IRS, but, so as not the defeat the purpose of the trust, your beneficiaries should not actually exercise their Crummey withdrawal rights.